Headlines vs. the Reality of Jobs & Housing

Last week the markets were giddy because the unemployment rate fell to 8.3% from a peak of 10% in October 2009. Who wouldn't love this chart?

But as with all things that have a political implication, we need to look a little deeper. Personally, I just glance at the unemployment rate, because it is a poor indicator of the state of employment in the US. I prefer to look at the percentage of the population employed. If we look at this chart, we find a very different story.

Civilian employment as a percentage of the population bottomed out in December 2009 at 58.2%. By January 2012, that number had risen only to 58.5%. Unprecedented levels of government spending to get the economy back on track, and employment has risen all of 0.3 percentage points!

If we really want to understand the economy, we can't stop here, because there is more to employment than just getting a paycheck. The size of that check is critical, since consumer spending accounts for about 70% of the GDP. So how are households doing these days?

According to the Census Bureau, median household income peaked in 1999 at $53,252 (in 2010 dollars). It has fallen 7.2% since then to hit a 14-year low! So even though employment might have improved a bit, people are making less than they did 12 years ago.

If incomes have been consistently falling, how did the economy grow so much? From 1999 to 2007, median home prices rose 54%, while median income fell 1%. Ahhhh, the beauty of home equity! The ratio of household debt to income has historically been around 65%, but that ratio starting to move up quickly in the mid-80s and produced explosive growth starting in the early 2000s, according to the Federal Reserve. By 2007, the ratio had peaked at nearly 140%. Since then, it has fallen only to just less than 120%.

So what does this tell us? The economic recovery is fragile and has not yet improved household finances. The recent proposal to help homeowners refinance to keep home prices up is not going to strengthen the economy, nor will it solve the housing problem. This is all about trying to boost home prices artificially to give people the impression that they are better off.

But this is yet another example of the government getting cause and effect all messed up and taking money away from one group to give it to another. Keep in mind that this refinancing would harm the owners of mortgage bonds, and those owners are primarily mutual funds, pensions, and real estate investment trusts. So, in trying to boost the price of my home, the government is going to raid my savings.

The price of anything is determined by supply and demand. The demand for housing is a function of three things:

1. Household income
2. Stability of that income (Will you need to move? Will your paychecks keep coming?)
3. Interest rates

The enormous rise in home prices was not caused by rising income levels, but rather by falling interest rates and an enormous expansion in the availability of mortgages. Houses were being purchased not to become a home, but as a fail-safe investment. This drove demand well beyond what it should have been. The exploding demand induced a construction boom. Now we have more homes than the reasonable level of demand in the economy can support.

The housing problem can only be solved by 1) letting the excess supply get worked out and 2) expanding the economy in a way that raises household income. Over the long run, no amount of government manipulation of interest rates and loan supply can counter the gravity-like reality of simple supply and demand.